China Is Susceptible To Currency Pressure

On Saturday, Beijing expressed its displeasure with the Obama administration, calling its criticisms of China's currency policies "untrue and misleading."

"We should avoid any excuse that might lead to the revitalization of trade protectionism," said Su Ning of the
People's Bank
of China, the country's central bank. "Directing unsubstantiated criticism at China on the exchange-rate issue will only help U.S. protectionism and will not help toward a real solution to the issue," blasted the Ministry of Commerce.

Beijing's coordinated attacks were directed at U.S. Treasury Secretary Timothy Geithner. "China is manipulating its currency," he stated in written responses to the Senate Finance Committee during his confirmation proceedings, summarizing the new president's views. "President Obama has pledged as president to use aggressively all the diplomatic avenues open to him to seek change in China's currency practices."

As the The Economist pointed out, "Mr. Geithner's language suggests a change in Washington's tactics towards China." Former Treasury Secretary Henry Paulson and his predecessors had worked behind the scenes to persuade Beijing to change its currency practices, but they were not especially successful over the last eight years.

The Bush administration, however, never cited China as a currency manipulator in any of its twice-yearly reports to Congress mandated by the Trade Act of 1988. Doing so would have required Treasury to open formal negotiations with China on the issue.

Today, Beijing actively intervenes in its market so that the renminbi hits a target in the middle of a tight band, and it does so to give an advantage to its exporters. Western commentators, however, have criticized Geithner for complaining about China's currency practices, and the market reacted negatively to his comments on manipulation. In fact, news of his statement momentarily moved the market for U.S. Treasuries. "The stakes are extremely high," The Economist warned.

They are. Yet Geithner did the right thing. As an initial matter, China is indeed manipulating its currency. The Bush administration's failure to confront Beijing surely emboldened Chinese officials and made it harder to persuade them to take steps in everyone's interest. Worse, the Bush approach helped spur protectionist sentiment in Congress, which perceived the White House to be ineffective on this matter.

Nonetheless, Bush's policy still has many fans. For one thing, everyone seems to worry about the "prickly" Chinese and how they will react to Geithner's words. Yet Beijing's leaders are not little children. On the contrary, they are ruthlessly pragmatic. And despite what some in Washington may think, they respond to pressure just like Americans--and like everyone else on the planet.

At this moment, Chinese leaders are especially vulnerable to outside influence. Last week, Beijing's National Bureau of Statistics announced that the Chinese economy grew 6.8% in the fourth quarter of last year. The number, however, was undoubtedly inflated. Growth was actually probably closer to 1%, and some analysts make the case that the economy actually contracted in December. No economy is decelerating at a faster pace (growth in 2007 was a spectacular 13% and fell every quarter last year).

A large reason for the precipitous decline in economic activity is that China's exports, a mainstay of the economy, are dropping rapidly as the global economy tumbles. Beijing's reaction has been to bolster its exporters; its major tool for accomplishing this goal was--and remains--intervention in its domestic market to fix the value of the renminbi.

President Obama's insight is that now is the time to act on Chinese currency practices, as Beijing has never needed its trade partners more. The problem for American negotiators, however, is that China never promised to let its currency float. Beijing is entirely within its rights to influence, manipulate, rig or fix currency values, and it is unlikely that Washington can devise retaliatory measures that are not themselves violations of America's trade commitments, especially those spelled out in the rules of the World Trade Organization.

If President Obama is to get the Chinese to do the right thing, he will have to offer them something they want. Fortunately, there is a lot they need at this moment.

The real risk for the U.S., however, is that Beijing will take too long to bring its currency practices in line with those of its trading partners. Asian nations are already depressing the value of their currencies to make their exports more competitive with China's. In the Great Depression, nations engaged in a tariff war that prolonged the downturn and made it deeper. This time, the beggar-thy-neighbor competition looks like it will be over currency.

So all of us have a lot riding on this matter. And the first thing we have to do is learn that criticizing protectionism is not itself protectionism.